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Annuities: Fool's Gold or Fiscal Smarts?

By Joan E. Lisante
ConsumerAffairs.com

March 20, 2006

Annuities • Annuities: Fools' Gold or Fiscal Smarts? • AARP Launches Annuity Program for its Members • Worried About Outliving Your Assets? You Should Be • Longevity Insurance: OK If You Live Long Enough --- • California Shuts Down Annuity Sales Scam • Minnesota Sues Another Annuity Insurer • North Carolina Shuts Down Living Trust Scheme • Illinois Sues Annuity Salesmen for Using Deceptive Mailers • Senior Investment Fraud Increases as Population Ages • California Sues "Living Trust Mill" • Merrill Lynch to Pay $10 Million in New Jersey Settlement • Pennsylvania Sues Living Trust Scheme • Consumer Complaints about Annuities

With pensions (or "fixed benefit retirement income") becoming as rare as true talent on "American Idol," workers nearing retirement are casting about for likely alternatives.

One of those alternatives, the annuity, sounds like a no-lose proposition. After all, the average American male lives to about 80; women, to 84. There are lots of doctors' visits and hopefully a few flights to the Caribbean between now and then -- enough to burn through your savings and more.

While they aren't the answer for every prospective retiree, you should know what annuities provide and why they could be a legitimate part of your retirement plans. One size investment never fits all, and the same holds true of annuities.

For starters, get familiar with the several types of annuities:

1) Fixed vs. variable annuities With a fixed annuity, your payment amount remains the same each month. Some think of this as creating your own "pension plan" in these days when fewer and fewer companies provide a "traditional" pension.

With a variable annuity, the amount you collect each month depends on how the stocks, bonds, or other investments in the underlying portfolio do. It can go up, but be careful: It can also go down.

2) Annuities indexed to inflation If you buy an inflation-indexed annuity, the true value of your monthly payments is less likely to shrink because of the erosion power of inflation. But this protection isn't free: your initial payments under the annuity will be lower, in anticipation of higher inflation-indexed payments years from now.

3) Annuities indexed to stock market performance Known as "equity-indexed annuities," these claim to shield you the investor from stock market losses by going up when share prices rise but not dropping when they fall.

If this sounds like a foolproof deal, many investors agree. The Wall Street Journal reports that, in 2004, sales of equity-indexed annuities rose 67%, to $23.4 billion. But to get a handle on your true yield, you must know whether the annuity calculates gains on a "point to point" basis or an "annual reset with monthly averaging" basis.

4) Immediate vs. deferred annuities An immediate annuity starts paying as soon as you buy it (or transfer funds into it.) A deferred annuity, by contrast, includes an "accumulation period" during which you pay premiums before your payments begin. Which you choose will depend on both your age and your financial health when taking out the annuity.

Which to Choose, If Any

Whether any of these products is right for you depends on several factors: your age at retirement, whether or not you'll continue to work, your other sources of income and the cost of your lifestyle. But before plunking down any hard-earned dollars, a few warnings are in order:

• Many people see annuities as solid, unchanging vehicles which deliver a certain amount of cash per month. Not always true. For example, an equity-indexed annuity might limit the amount of money you lose, but it also limits the amount of money you gain by measures such as restricting investors from participating in stock dividend payments. And watch for your company's reserving the right to change the formula for that "guaranteed return," based on variables like a longer-than-normal life expectancy.

• American consumers/investors have relied on the Securities and Exchange Commission (SEC) to protect their investments since just after the Great Depression. Many continue to believe that most investments are regulated by the federal government. Not necessarily so with annuities. For example, equity-indexed annuities are considered "insurance products" rather than securities, and regulated by each state's insurance regulator. Not exactly across-the-board protection.

• Annuities may be long-lived, but there's one things they're not: easy cash. Withdrawing from an annuity contract, should you need the money, can be painful. If you take your money out during the "accumulation period" (typically 6-10 years,) you can be charged a surrender fee (typically 7-20%.) One other caveat: tap your funds before age 59 1/2, and you'll owe the IRS a 10% penalty. So keep a couple of eggs outside this basket.

• Monthly payments for women are usually less than those for men, simply because women tend to outlive men. Keep this in mind when planning your retirement budget.

More Regulation Ahead?

Because annuities come in different flavors and can be difficult to understand, a movement for tighter regulation of annuity sales is underway. The National Association of Insurance Commissioners (NAIC) has proposed regulations to see that buyers get the product that's appropriate for their financial needs.

The NASD, a private-sector provider of financial regulatory services, recently fined Syosset, New York–based David Lerner Associates $400,000 for violating rules enacted to protect buyers of variable annuities. So it looks like oversight in this market is increasing.

But until protections are stronger, be your own financial advisor by observing a few savvy-consumer rules before buying an annuity:

• Check the financial health of the company that sells your annuity. You're betting that they'll still be around in 20 or 30 years, so they'd better be financially sound. Companies that offer annuity products include Vanguard, New York Life and Genworth Financial. You can check ratings in directories such as A.M. Best, Moody's or Standard & Poor's.

• Don't neglect other retirement vehicles, such as IRAs and 401(k)s. The Securities and Exchange Commission recommends that consumers maximize their contributions to popular, tax-advantaged retirement choices before buying an annuity.

• Recognize the relationship between interest rates when you buy your annuity and later payouts. If long-term interest rates are low when you purchase, your monthly check may not be as large as you'd hoped. You may be better off investing in products yielding higher short-term interest rates (such as CDs) and skipping that annuity for now.

• If your spouse depends on your income, make sure the annuity you purchase contains a survivor's benefit.

• Balance is the key to any workable investment plan. Even if you decide on an annuity, don't close the door on keeping part of your savings in equities, CDs, or Treasury notes. Do this right and, even if you give Methuselah a run for his money, your money can still be rolling in with an annuity that fits your pocketbook and lifestyle.

Resources

But don't take our word for it. Here some some other resources that will help you make the right decisions.

Books

• The Pocket Idiot's Guide to Annuities by Ken Little (Alpha, 2005), $9.95
• Getting Started in Annuities by Gordon K. Williamson (Wiley, 1998), $19.95

Web sites

• Securities and Exchange Commission
• NASD
• Quicken's annuities section
• About.com

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